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Board Characteristics Best Practices and Financial Performance.


Evidence from the European Capital Market

BOARD CHARACTERISTICS BEST PRACTICES AND FINANCIAL


PERFORMANCE. EVIDENCE FROM THE EUROPEAN CAPITAL MARKET
Victor-Octavian Mller1, Ionel-Alin Ienciu2, Carmen Giorgiana Bonaci3*
and Crina Ioana Filip4
1) 2) 3) 4)
Babes-Bolyai University, Cluj-Napoca, Romania

Abstract
This study investigates board characteristics best practices in the particular context of
European listed companies. The theoretical grounding of the paper is done by discussing
board composition and board compensation related studies, mainly belonging to the
corporate governance literature. The main objective of the paper is to contribute to the
debate on whether certain board characteristics can be documented to represent best
practices. In doing so, we investigate if such board characteristics significantly influence
companies financial performance. We use econometric regression models in order to
assess the impact of a series of corporate governance board related characteristics on the
performance of companies (constituents of FTSE100) listed on the largest European capital
market (London Stock Exchange), for the 2010-2011 period. An accounting measure of
operating performance, namely the operating return on assets (ROA), is used. The
profoundness of a potential impact of corporate board characteristics on companies
performance is investigated by considering both contemporaneous and subsequent
operating performance. Results document best practices through the existence of several
significant associations between considered board characteristics and firm performance.
Keywords: board composition, board compensation, best practices, operating return on
assets, corporate governance, FTSE 100, OLS regression.
JEL Classification: M12, M40, G30
Introduction
As Solomon (2009) emphasizes, in order for a company to be successful, it has to be well
governed, a well-functioning and effective board of directors therefore being the holy
grail searched for by every ambitious company (Solomon, 2009, p. 77). The UK
Combined Code of Corporate Governance (Financial Reporting Council -FRC, 2003) states
that each company should be headed by an effective board that is collectively responsible
for its success (FRC, 2003, p. 4). The dynamic of the business environment, as well as
evolutions in stakeholders expectations led to significant scrutiny of listed companies
boards. While it would be difficult to develop a recipe for a board that guarantees the
*

Corresponding author, Carmen Giorgiana Bonaci, carmen.bonaci@econ.ubbcluj.ro

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success of the company, a significant body of literature (mainly falling in the area of
corporate governance) investigates the potential association between corporate board
characteristics and corporate performance. To a larger extent, our paper contributes to the
literature exploring this association, while focusing on best practices.
More precisely, this study aims at informing the debate on whether certain board
characteristics can be documented to represent best practices. Undoubtedly, a wellfunctioning and effective board would require focus on elements such as structures, roles,
responsibilities, processes, but also on competences and abilities of the directors. The first
step of our analysis is based on discussing research literature in the approached area with
the purpose to identify corporate board characteristics that can be argued to represent best
practices. In doing so, we present arguments being put forward by previous studies. Such
an approach allowed us to select corporate board characteristics that were further
considered in the developed empirical analysis. The analyzed corporate board
characteristics belong to two big categories covering board composition and board
compensation.
The empirical analysis helps document board characteristics best practices which are
expected to present potential for a positive impact on companies performance. In this
regard we develop research methodology mainly based on econometric regression models.
We therefore investigate if such board characteristics significantly influence companies
financial performance. The latter is explored with the help of an accounting proxy, namely
operating return on assets.
Among the particularities of our study we must mention its positioning in the European
context as our sample companies are the constituents of FTSE100. We consider the
companies being listed on the largest European capital market (LSE) to offer an interesting
research setting due to the complexity of their activities imposing an extremely well
thought governance. The period under analysis is between 2010 and 2011. Another
particularity of the study is that it looks into the profoundness of the potential impact of
corporate board characteristics on companies performance by considering both
contemporaneous and subsequent (next years) operating performance, following an idea
suggested by Bhagat and Bolton (2008). Our paper therefore contributes to the literature by
bringing insights on board characteristics best practices in the context of the European
capital market.
The remainder of the paper is organized as follows. Section one synthesizes previous
studies in the area of corporate governance and informs the selection of the considered
board characteristics. Section two displays the details of the employed research
methodology. Section three presents and discusses the results obtained by performing the
empirical analysis. The final section of the paper concludes upon the obtained results and
its contribution together with research limitations and perspectives for future extensions of
the study.
1. Literature review
A significant number of studies investigate the role of boards in corporate governance,
mainly drawing from the agency theory, the finance paradigm of corporate governance and
boardroom effectiveness (Solomon, 2009, p. 104; Paun and Paun, 2010). In the context of
listed companies growingly challenging environment, the optimal mix of boards remains a
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Board Characteristics Best Practices and Financial Performance.


Evidence from the European Capital Market

highly debated topic. Questions have been raised both within the boards, as well as coming
from stakeholders. Among such highly debated issues related to corporate boards, we find
their composition and compensation which also represent the focus of our analysis.
Developing a brief analysis of literature supports our study by identifying best practices in
this area from a theoretical point of view, together with the arguments on their behalf.
Buniamin et al. (2008 cited by Ienciu, 2012) and Neamtu (2012) discuss the idea in
accordance to which a larger board size can bring directors with experience and this may
translate into a multitude of values on the board. Board size is a variable being considered
by many studies (Jensen, 1993; Xie et al., 2003; Buniamin et al., 2008; Sun et al., 2010;
Allegrini and Greco, 2011; Ranasinghe, 2011) and generating mixed evidence. While
benefits such as leading towards more experienced independent directors (Xie et al., 2003)
may help diminish managers opportunistic behavior, Jensen (1993) discusses that idea of
board size being negatively related to the ability of the board to pursue long-term strategic
goals (cited by Sun et al., 2010).
Non-executive directors and independent directors role in corporate governance is also
discussed in a number of studies (Haniffa and Cooke, 2002; Haniffa and Cooke, 2005;
Khodadadi et al. 2010; Arora and Dharwadkar, 2011 and Michelon and Parbonetti, 2012).
Solomon (2009) emphasizes that non-executive directors need to have integrity and high
ethical standards, sound judgment, the ability and willingness to challenge and probe on
issues, as well as strong interpersonal skills (Solomon, 2009, p. 82). Non-executive
directors have to monitor insider directors and meanwhile contribute to corporate strategy,
tasks which are not easy to balance (Ezzamel and Watson, 1997; Spira and Bender, 2004).
Overall, evidence on the role of non-executive directors is also mixed, pros mainly relating
to their monitoring role on the rest of the board, while cons discussing them to be
superfluous and merely another impotent element in an unnecessary structure (Solomon,
2009).
Gender represents another characteristic that generates intense debates. Macarie and
Moldovan (2011) argue different psychological mechanisms to determine individual
manifestations in the form of discrimination against females. Ernst & Young (2013)
develops a study on board diversity at S&P 1500 companies, documenting that, as of 2013,
85% of board seats were held by men, despite more women joining boards. Therefore,
change seems to be slow in this direction. Another element of board composition that
should be considered is tenure (see Goodwing et al., 2009). The previously mentioned
study also documents (for the same time period) that about 45% of board seats were held by
individuals who seem to have served for ten years or longer, while 27% of these seats were
held by persons with age 68 or older (Ernst & Young, 2013). Our analysis also investigates
foreign directors due to the fact that, when companies enter new markets, their international
experience might prove extremely helpful.
When it comes to stimulating directors and making sure the company benefits of an
appropriate board, we must also turn our focus towards compensation related issues. As
Larcker (2011) emphasizes, board compensation should be sufficient in order to attract,
retain, and motivate qualified directors. The second set of variables being considered in our
analysis therefore fall in the category of board compensation related characteristics. As
Solomon (2009) emphasizes, a large number of studies relate to executive remuneration,
focusing on several aspects such as remuneration committees (Bostock, 1995), disclosure
of executive remuneration (Cheffins, 2003), pay levels (Thompson, 2005), voting directors
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remuneration (Mayo and Young, 2002), etc. Summing up, as Larcker (2011) discusses,
compensation should cover time directly spent on board matters, the cost of keeping
schedule flexible, as well as corporate financial and reputational risk, while fees are meant
to compensate expertise, time and potential risk of committee role. Faulkender et al. (2010)
develop a study on board compensation practices and reforms, informing the debate on
corporate executive compensation. More precisely, their research analysis covers the level
and structure of executive pay while also debating the pay-setting process. Discussing the
recent financial crisis, they conclude that, despite the fact that executive pay was one of its
factors, an approach preventing such future occurrences will not be reached through
changes that focus on pay alone. They advise that any future proposals related to board
compensation should be approached as a part of the much larger process of financial
regulatory restructuring.
All the above discussed characteristics offer the theoretical grounding for the variables
considered in our empirical analysis meant to document best practices in the context of the
European capital market. Some of the considered variables in our study combine board
composition and structure (such as non-executive remuneration). Considering fees being
paid in shares also allows us to construct a dummy variable based on board compensation
characteristics. Further details on the board composition and compensation characteristics
being included in our analysis (together with the manner in which they were determined)
are presented in the following section being dedicated to research methodology related
aspects.
2. Research methodology
Within this paper we analyze the association between board composition and compensation
characteristics on the one hand, and company performance on the other, for companies
listed on the London Stock Exchange (LSE). We consider the chosen stock exchange to
represent an appropriate setting in relation to the papers objective of documenting best
practices, as LSE is the largest European stock market. The analysis covers the 2010-2011
period. We selected those companies belonging to the main index (FTSE 100), which is
comprised of the first 100 largest and most traded companies on the respective stock
exchange.
We based our empirical research on an accounting measure of company performance (as
opposed to stock market based measures), and therefore we used operating return on assets
(dependent variable) as a proxy for company performance. According to previous literature,
stock market based measures of company performance can be susceptible to investor
anticipation (Bhagat and Bolton, 2008, p. 264). Consequently, if investors anticipated the
effect of corporate governance characteristics on company performance, then long-term
stock returns would not be correlated with corporate governance, even in the case when a
significant correlation between firm performance and governance would exist (Bhagat and
Bolton, 2008, p. 264).
The financial information regarding operating performance, total sales, total assets,
shareholders equity, as well as industry related information for the constituents of FTSE
100 has been manually collected from the official London Stock Exchange webpage.
Regarding the data on corporate board composition and compensation characteristics, it has
been obtained from the 2011 SpencerStuart UK Board Index. Several dependent and

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Board Characteristics Best Practices and Financial Performance.


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independent variables, including control variables (for size, respectively for industry) have
been constructed. With regard to the elimination of outliers, we chose the following
approach: we truncated those observations for which the dependent variable (return on
assets) was below the 5th, respectively above the 95th percentile.
Our research involves four hypotheses, which are based on prior findings in research
literature. The first two are as follows:
Hypothesis 1: Corporate board composition characteristics (board size, board
independence, percentage of foreign directors, average service, tenure, age,
percentage of women directors) can significantly influence the companies
operating performance in the current year.
Hypothesis 2: Corporate board compensation characteristics (chair remuneration,
non-executive director remuneration, additional remuneration for board
committee meetings, fees paid in shares) can significantly influence the
companies operating performance in the current year.
With the purpose of testing these research hypotheses regarding the influence of board
characteristics on the current year operating performance, the following econometric model
has been developed, whose parameters are to be estimated using ordinary least square
(OLS):
ROAni = 0 + 1*NumDiri + 2*IndNExi + 3*ForDiri + 4*WomDiri + 5*AvServNExi
+ 6* ChairTenurei + 7* CEOTenurei + 8*AvAgeNExi + 9*AvAgeExeci +
10*ChairRemi + 11* SenNExRemi + 12* NonExBasFeei + 13* FeesInSharesi + 14*
AddRemBComMembi + 15*TAi + (i*Indi) + i
(1)
Where:
ROAni
= Operating Return on Assets for company i in year n
NumDiri
= Number of Board Directors for company i
IndNExi
= Independent non-executive directors divided by number of directors
for company i
ForDiri
= Foreign directors divided by number of directors for company i
WomDiri
= Women directors divided by number of directors for company i
AvServNExi = Average service of non-executive directors for company i
ChairTenurei = Chairman tenure for company i
CEOTenurei = CEO tenure for company i
AvAgeNExi = Average age of non-executive directors for company i
AvAgeExeci = Average age of executive directors for company i
ChairRemi
= Chairman remuneration for company i
SenNExRemi = Senior non-executive total remuneration for company i
NonExBasFeei = Non-executive director basic fee for company i
FeesInSharesi = Fees paid in shares for company I (dummy variable)
AddRemBComMembi =
Additional remuneration for board committee members
for company i
TAi
= Natural logarithm of total assets for company i
= Industry dummy variable for the industries: Basic Materials,
Indi
Industrials, Consumer Goods, Consumer Services, Utilities, Financials, Other
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Additionally, we designed our empirical research to also investigate the impact of board
composition and compensation characteristics on companies operating performance in the
subsequent (next) year. This follows up a research idea discussed by Bhagat and Bolton
(2008). Accordingly, the next two additional hypotheses based on the previous ones have
been formulated:
Hypothesis 3: Corporate board composition characteristics (board size, board
independence, percentage of foreign directors, average service, tenure, age,
percentage of women directors) can significantly influence the companies
operating performance in the next year.
Hypothesis 4: Corporate board compensation characteristics (chair remuneration,
non-executive director remuneration, additional remuneration for board
committee meetings, fees paid in shares) can significantly influence the
companies operating performance in the next year.
In order to test these research hypotheses regarding the influence of corporate board
characteristics on the companys next year performance, a second (similar) model was
developed, whose parameters are to be estimated using ordinary least square (OLS):
ROAn+1i = 0 + 1*NumDiri + 2*IndNExi + 3*ForDiri + 4*WomDiri +
5*AvServNExi + 6* ChairTenurei + 7* CEOTenurei + 8*AvAgeNExi +
9*AvAgeExeci + 10*ChairRemi + 11* SenNExRemi + 12* NonExBasFeei + 13*
FeesInSharesi + 14* AddRemBComMembi + 15*TAi + (i*Indi) + i
(2)
Where:
ROAn+1i

= Operating Return on Assets for company i in year n + 1

Similar to other previous studies (such as Allegrini and Greco, 2011; Sun et al., 2010;
Guest, 2009; Buniamin et al., 2008; Vafeas and Theodorou, 1998), our regression models
have been designed to include control and dummy variables. More precisely, we use a
control variable for company size (natural logarithm of total assets), as well as dummy
variables to control for the industry the companies primarily operate in (namely Consumer
Services, Consumer Goods, Industrials, Basic Materials, Utilities, Financials, and Other).
These control variables are used in order to capture the influence of company size and
sector on companys operating performance, hence improving the explanatory power of the
two regression models being developed. For confirming each of the four research
hypotheses, the coefficient of at least one variable related to the particular board
characteristic must be statistically significant at the 0,1 level and it also has to record a VIF
(Variance Inflation Factor - which tests the correlation between the independent variable
and other independent variables) below 5. Otherwise, the particular hypothesis would be
considered infirmed.
3. Results
The main results for the relationship between the companies operating performance (return
on assets) for the current period and the corporate governance characteristics (board
composition and compensation) are summarized in Table no. 1. These results indicate a
statistically significant relationship (at least at 0,1 level) between the current year operating
performance (ROA) and some of the board composition characteristics (number of
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directors, board independence, proportion of foreign directors, average service of nonexecutive directors, CEO Tenure, and proportion of women directors), respectively board
remuneration characteristics (non-executive director basic fee, the additional remuneration
for board committee members, and the fees paid in shares).
Table no. 1: Regression model 1 - empirical results
Variable
(Constant)
NumDir
IndNEx/NrDir
ForDir/NrDir
WomDir/NrDir
AvServNonEx
ChairTenure
CEOTenure
AvAgeNonEx
AveAgeExec
ChairRem
SenNExRem
NonExBasFee
FeesInShares
AddRemBComMemb
TAn
IndBasMat
IndInd
IndConsGoods
IndConsServ
IndUtilities
IndFinancials
IndOther
Model Summary ROAn

Coefficients ()
0,238**
0,005**
0,091*
0,088***
0,127*
0,007**
-0,001
-0,002**
-0,002
0,000
0,000
0,000
0,002***
0,025*
0,037***
-0,033***
0,045
-0,048
-0,008
0,000
0,028
0,012
0,020
2
AdjR 0,561

t
2,147
1,998
1,749
3,069
1,715
2,54
-1,104
-2,222
-1,258
-0,437
-0,474
-1,48
3,375
1,697
3,674
-5,628
2,596
-2,770
-0,428
-0,032
1,349
0,648
0,973
F 4,879

Sig.
0,036
0,050
0,086
0,003
0,092
0,014
0,274
0,030
0,214
0,663
0,637
0,144
0,001
0,095
0,001
0,000
0,012
0,008
0,67
0,975
0,183
0,519
0,334

VIF
2,448
1,703
2,898
2,464
1,669
1,598
1,92
1,682
1,526
2,833
3,213
3,222
1,564
1,611
4,943
2,814
2,796
2,004
2,21
2,012
3,353
1,684

The relatively strongest, as well as statistically significant, influence of the characteristics


regarding board composition on the operating performance (ROA) can be identified for
board independence, proportion of foreign directors, respectively the proportion of women
directors. Worth mentioning are also other two relationships which involve the number of
directors and the average service of non-executives. Noticeable is also the negative
significant relationship between operating performance (ROA) and CEO Tenure (0,002).
The relatively strongest as well as statistically significant influence of the characteristics
regarding board remuneration on the operating performance (ROA) can be attributed to the
additional remuneration for board committee members. Worthwhile to remark is also the
relationship between operating performance (ROA) and the (dummy) variable for the fees
paid in shares. Regarding the potential multicollinearity between independent variables of
the two models, which can generate instability of the empirical results, we computed the
variance inflation factor (VIF) for each coefficient of the independent variables. The

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computed VIF values (which are less than 5) do not indicate (serious) autocorrelation
problems between the considered independent variables.
Thus, taking into account the empirical results obtained from the first regression, we can
undoubtedly confirm both hypothesis 1, (referring to a significant relationship between
board composition and current performance) and hypothesis 2 (referring to a significant
relationship between board compensation and current performance). As mentioned within
research methodology, we designed our empirical research also to investigate the influence
of board (composition and compensation) characteristics on companies operating
performance in the subsequent (next) year. Statistically significant coefficients based on
next years ROA would clearly strengthen a supposed conclusion concerning the existence
of a relevant influence of corporate board (composition and compensation related)
characteristics on firm performance. In Table no. 2 we summarize the obtained empirical
results.
Table no. 2: Regression model 2 - empirical results
Variable
(Constant)
NumDir
IndNEx/NrDir
ForDir/NrDir
WomDir/NrDir
AvServNonEx
ChairTenure
CEOTen
AvAgeNonEx
AveAgeExec
ChairRem
SenNExRem
NonExBasFee
FeesInShares
AddRemBComMemb
TAn
IndBasMat
IndIndustrials
IndConsGoods
IndConsServ
IndUtilities
IndFinancials
IndOther
Model Summary ROAn+1

Coefficients
()
0,327***
0,004
0,146**
0,049*
0,053
0,003
0,000
-0,001
-0,002
-0,002
0,000
0,000
0,001*
0,021
0,043***
-0,028***
0,050
-0,048
-0,037
-0,049
-0,055
-0,079
0,005
AdjR2 0,511

Sig.

VIF

2,837
1,386
2,531
1,513
0,685
1,144
-0,674
-1,058
-0,954
-1,251
-1,34
-0,419
1,977
1,31
4,086
-4,299
2,965
-2,77
-1,759
-2,683
-2,57
-3,765
0,215
F 4,887

0,006
0,171
0,014
0,136
0,496
0,258
0,503
0,294
0,344
0,216
0,186
0,677
0,053
0,195
0,000
0,000
0,020
0,008
0,084
0,01
0,013
0
0,83

0
2,842
1,812
3,282
2,441
1,619
1,536
2,052
1,815
1,513
3,026
3,536
3,36
1,536
1,601
5,857
2,814
2,796
2,616
2,805
2,219
3,505
2,272

The tabulated results show a statistically significant association, at least at 0,1 level,
between next years company performance (ROA) and board characteristics such as board
independence, the proportion of foreign directors, non-executive basic fee, as well as the
additional remuneration for board committee members. It has to be underlined that the
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coefficient for the board independence variable and the coefficient for the variable
concerning the additional remuneration for board committee members even record a higher
statistical significance (and also a higher positive value) in comparison to model 1 (which is
based on current ROA). This indicates that board independence and the respective
compensation component might have a stronger impact on the companies operating
performance on a longer term.
As for the potential multicollinearity between independent variables of the second model
(which might generate instability of results), the obtained variance inflation factor (VIF)
(less than 5), does not indicate (serious) autocorrelation problems between the considered
independent variables. Based on the statistical results obtained from the second considered
regression model including statistically significant coefficients, we may confirm both
hypothesis 3 (concerning a significant relationship between board composition and next
years operating performance) and hypothesis 4 (concerning a significant relationship
between board compensation and next years operating performance).
Conclusions
Our study informs the debate on whether certain board characteristics (regarding its
composition and compensation) can be documented to represent best practices in the
particular context of European listed companies. In doing so, we first discuss previous
studies in the area of corporate governance. This provides us with the necessary theoretical
grounding of board characteristics (related to board composition and board compensation)
which are further empirically investigated through our analysis. Assessing what board
characteristics might be considered best practices is done by testing their potential
association with firms financial performance. Thus, to a larger extent, our paper
contributes to the research literature on the unsettled debate regarding the relationship
between corporate performance and corporate governance.
The literature review section of the paper allowed us to identify a series of board
characteristics together with the arguments putting them forward as best practices in the
area of corporate governance. The identified best practices were grouped into two main
categories: board composition (covering characteristics related to number of board
directors, independent non-executive directors, foreign directors, women directors, average
service of non-executive directors, chairman tenure, CEO tenure, average age of nonexecutive directors, average age of executive directors) and board compensation (covering
characteristics related to chairman remuneration, senior non-executive remuneration, nonexecutive director basic fee, fees paid in shares, additional remuneration for board
committee member).
By using econometric regression models, we investigate the impact of a series (14) of board
composition and compensation characteristics on contemporaneous and subsequent
performance while using a sample of companies listed on the largest European capital
market (LSE) for the 2010-2011 period. The selection of the companies was done by
including the constituents of FTSE 100. The analysis employs an accounting measure of
operating performance, more precisely the operating return on assets (ROA). We also
analyze the profoundness of the potential impact of corporate board characteristics on
company performance by considering the influence of the investigated characteristics both
on contemporaneous and on next years operating performance.
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The obtained results document a statistically significant relationship between company


performance and the considered board characteristics. This is true when considering both
contemporaneous and subsequent firm performance. We were therefore able to confirm all
the hypotheses that we formulated in the research methodology section of the paper.
Furthermore, the obtained results are in accordance to other previous studies in literature,
such as Vafeas and Theodorou (1998), Gompers et al. (2003), Bhagat and Bolton (2008),
Tian et al. (2009), Guest (2009), Ujunwa (2012) and Shukeri et al. (2012).
We manage to document a statistically significant relationship between company
performance and corporate board composition and compensation characteristics. Among
the main conclusions of our study, we document that board independence and the
proportion of foreign directors in the total number of directors have a significant strong
positive influence on company performance (both contemporaneous and subsequent). The
relationship between non-executive directors basic fee, fees paid in shares and additional
remuneration for board committee membership, on one hand, and company performance
(both contemporaneous and subsequent), on the other, was also documented to be
statistically significant. Interestingly, chair remuneration as well as senior non-executive
remuneration were not documented to exert a statistically significant influence on operating
performance.
The developed empirical analysis mainly serves the purpose of our paper by documenting
current board characteristics best practices in the context of the European capital market.
The obtained results allow us to consider the following board characteristics as best
practices (due to recording significant strong positive influence on both contemporaneous
and subsequent company performance): board independence, foreign directors, nonexecutive directors basic fee, fees paid in shares and additional remuneration for board
committee membership.
Summing up, we must mention the limitations of the study mainly referring to sample
representativeness and potential endogeneity related issues. In relation to sample
representativeness, we must display caution in interpreting results when approaching large
European capital markets as opposed to the whole European capital market. As limitations
also point potential future developments, further extension of the analysis might include
considering other stock exchanges in Europe and maybe even companies which are not part
of their main index. Endogeneity related issues refer to potential relationships between the
main considered elements (corporate governance, corporate structure, ownership structure
and operating performance).
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